As a growing company, you may feel like that proverbial duck skimming smoothly across the lake surface. Only you are aware of all the frantic paddling going on beneath the surface to keep moving your company forward. There’s innovation. There’s development, There’s marketing. There’s distribution.
In getting all these ducks in order, one crucial component in the finance and back office operation is ensuring your company is in compliance. As you seek investors for your fledgling enterprise and prepare for the due diligence these investors must undertake, compliance will be a primary consideration in their decision-making.
What Is Compliance?
As an entrepreneur and innovator, you will be fully knowledgeable about your field, your product and/or your service, but you might not be fully versed in investment terminology and strategy.
You might not be clear on what compliance means from a business and investor standpoint. Simply put, compliance means you are abiding by all the rules and regulations that affect your industry.
Of course, compliance is going to vary from industry to industry. A financial services business will have a different set of regulations to meet in comparison to a manufacturing company. A retail or software company must abide by a completely different set of regulations.
A well-run business, one that will appeal to investors, also will have a set of internal regulations, especially when it comes to finances, and a system for ensuring those internal regulations are followed.
If you’re brand new to seeking investors, you also may not feel certain about the term “due diligence.” Just to quickly define, due diligence is a process the investor goes through, usually pretty clearly defined, of investigating your company to ensure all the information you have provided to the investor is accurate and complete.
For the remainder of this blog post, we’re going to look at the primary financial and back office issues in which a startup company must be in compliance to be prepared for due diligence.
Sales Tax Compliance
Because the majority of startups involve the sale of a product or service, companies need to ensure they are collecting and paying all applicable sales taxes. Until recently, this was a simple process. If you had a physical store, you collected the sales tax for your state, city and other taxing districts and returned it to the state.
But in the Internet age, companies are doing business across the country, if not around the globe. For decades, companies could just ignore sales taxes as states took time to catch up with the changing face of business. Economic nexus, which is the level of connection between a taxing jurisdiction such as a state and an entity such as your business drives sales taxability. These connections are driven by anything from where employees are, locations are, sales take place and even where servers are located and more. The very nature of the SaaS business model puts SaaS companies at risk of establishing economic nexus in multiple states. Most SaaS companies use a subscription model, charging customers on a monthly or annual basis for the service, and it doesn’t take long to reach 200 transactions per year when customers are billed monthly. Instead of making one sale to 200 customers in a state, SaaS sellers making 12 sales per year to fewer than 20 customers could establish economic nexus in states that have a transaction threshold.
First, states were only collecting sales taxes from companies selling to customers within the state where they were based. Then states were allowed to collect sales tax from any business that had any kind of physical presence in their state. For example, if Amazon had a distribution center in a particular state, that state could collect sales tax from Amazon.
But in 2018, the U.S. Supreme Court changed the game when it ruled in South Dakota v. Wayfair, Inc., that states could collect sales tax on remote sales based on an economic nexus. The ruling basically says states can say companies have a presence in the state if they do a certain amount of business with customers in that state. States can define the economic nexus based on sales revenue, transaction volume or a combination of the two. Download a free guide to sales taxes from our partner Avalara.
Back to our Amazon example: Even if Amazon has no physical presence in South Dakota, but does $250,000 in annual sales to customers within the state, Amazon now is responsible for collecting sales tax from those customers and returning it to the state.Now with states scrambling to take advantage of this opportunity, startups that sell product or services across state lines now must be prepare to ensure they are compliant with sales tax regulations in all those jurisdictions.
Collecting these sales taxes can become extremely complicated as taxes are imposed by cities, counties, townships and even public libraries. This creates thousands of taxing configurations across the country with which your company must comply.
Payroll and HR Compliance
All companies with employees are required to withhold funds from employees’ paychecks to meet their income tax and FICA obligations, and in that role to also file certain documents with the Internal Revenue Service. Some of those filing requirements have changed in recent years but here are the basics:
- W4: Companies no longer are required to file a copy of a W4 for each employee, but must comply if the IRS requests the copy of a W4 for a certain employee. If the IRS believes an employee is not having enough taxes withheld based upon the W4 filed with your company, the IRS will issue a “lock in” letter to the company requiring you to withhold more taxes. As that lock in letter remains in effect, your company must withhold the IRS-requested amount, even if your employee files a new W4 requesting less withholding.
- W2: Companies must supply W2 forms listing wages and withholding for taxes, Social Security and Medicare to all employees and file copies with the Social Security Administration generally by January 31 of the following year. Companies with employees in U.S. possessions besides Puerto Rico also must file special W2 forms to those governments.
- Form I-9: Companies must complete a Form I-9 for each employee hired since November 6, 1986, both citizens and non-citizens confirming their eligibility to work in the United States. Companies must keep these forms on file and make them available to U.S. government agents upon request. Companies involved in federal contracting may be required to use the federal government’s E-verify system to confirm the information employees provide on the Form I-9 is correct. Some states also require employers to use the E-verify system.
- Employee compliance is a whole of other can of worms and also varies state by state. Ensuring proper HR policies are in place is imperative and a solid foundation around communication in the form of an employee handbook is a great start. Download a free guide on developing an employee handbook from our payroll partner Gusto.
Contractor Compliance
Any company that uses contractors or contract workers is required to file a 1099-MISC with the IRS and provide a copy to the contractor if the contractor was paid more than $600 during the year.
Your company also must file a 1099-MISC if you sold more than $5,000 worth of a consumer product to a buyer for resale outside of a permanent retail location. This could affect your company if you supply products to independent sales persons or used contractors to perform projects for your business over $600 and includes all payments over $600 to legal consultants and rent vendors.
Get Compliance Assistance
As you might better understand from these examples, compliance is a complicated process for businesses and we didn’t even touch on internal regulation compliance in these instances.
Larger companies oftentimes will have compliance officers or compliance executives to oversee the entire process. But for a startup company, which often is operating on a shoestring budget, compliance contracting provides a more economical option for this vitally important function. Contact us today to learn how BizVisory can bring your compliance management under control. Additionally, we offer technology solutions to bring all of your HR, payroll, sales tax and finances under one integrated system.